Expecting stimulus to ease the trade pain
The data out of Asia-Pacific has had a disappointing tone in the second quarter, led by China and South Korea. Exports from the region have slowed, while manufacturing activity growth (as reflected by recent Purchasing Managers’ Indices) has slowed or in some countries, including South Korea and Taiwan, continued to contract. The Indian election saw the re-election of Prime Minister Narendra Modi, which should provide some support to the economy. Japan’s economy continues to look lackluster, with the planned raising of the value-added tax remaining a risk watchpoint.
As always, let’s start in China. In our previous quarterly outlook, we said we were becoming more constructive on growth, driven by stimulus measures that had been announced. Since then, the data has been mixed to soft and the trade war has escalated. However, it is not all bad news, with more stimulus measures likely to come. This will likely focus on infrastructure spending (which has disappointed). Comments from the People’s Bank of China’s governor suggest that monetary policy may also ease, and we will be watching the credit numbers for signs of credit impulse.
Activity in India has faced temporary headwinds of pre-election uncertainty and some regulatory changes in the autos sector. Both should dissipate in coming months, given the Modi government’s retainment of a majority in India’s recent general election. Additionally, the outlook for investment has been boosted by the accommodative stance that has been taken by the Reserve Bank of India, which has cut interest rates twice in the last three months. The key risk to the outlook is the tight financial conditions that are seen in the non-banking financial sector, which has a market share of close to 40% in housing and auto loans.
We remain cautious on the outlook for South Korea and Taiwan, given their exposure to trade. In South Korea, the outlook for the consumer has deteriorated (consumer confidence has fallen, and retail sales growth has decelerated) and the manufacturing sector is struggling (the PMIs are in contraction territory). We still expect that the Bank of Korea will shift to an accommodative stance and a rate cut may come later this year. Taiwan is also facing the headwinds of soft consumer spending and weaker external demand.
The Q1 GDP print from Japan was very strong, however, and most of the strength came from a fall in imports (which boosts GDP but suggests flagging domestic demand). Consumer spending has been reasonably solid, despite soft consumer sentiment, while business confidence has taken a hit due to the U.S.–China trade confrontations. Political developments have decreased the likelihood of a delay in a value-added tax (VAT) rate hike, which may also be hurting business confidence. It is worth noting, however, that there are a number of counter measures in place to assist with the hike.
The outlook for Australia remains lackluster, although there have been a number of positive developments that should help the housing market stabilise. First, the Liberal-National Coalition government was re-elected in a surprise victory. This removes uncertainty around tax treatment of investment property. Second, there are some changes to macro-prudential regulation, which will provide borrowers with increased capacity to borrow. Finally, the Reserve Bank of Australia (RBA) cut rates and appears likely to cut again this year. The RBA remains focused on the labour market, however recent research has suggested that the natural rate of unemployment is lower than previous estimates, which gives the RBA scope to become more accommodative.
Finishing off in New Zealand, where the key development has been the dovish shift from the Reserve Bank of New Zealand (RBNZ). The outlook for the economy has softened, with business confidence remaining very soft and the labour market showing signs of slowing. The RBNZ have responded by cutting rates in May, and we are likely to see another cut sometime this year.
- Cycle: Risks have risen for the region, given the escalation in trade-war threats. However, expected additional Chinese stimulus will be supportive. Central banks have been becoming more supportive.
- Valuation: We see slightly attractive valuations in Japan and Emerging Asia, while the Australian equity market is fully valued. New Zealand equities continue to look expensive. Bond valuations in the developed economies look expensive. Overall, valuations on offer appear reasonable.
- Sentiment: The flows resulting from index provider Morgan Stanley Capital International’s (MSCI) decision to increase the weight of mainland China in its global index are expected to continue with the announced incremental rise in August and November. Our contrarian sentiment signals are broadly neutral for Emerging Markets and Japan.